U.S. accuses London trader of helping cause 2010 "flash crash"

By Michael Holden

LONDON (Reuters) - A London-based trader accused of helping cause the 2010 Wall Street "flash crash" was operating a legitimate trading strategy rather than placing bogus orders to spoof the market, a British court heard on Thursday.

Navinder Sarao, 37, is fighting extradition to the United States where he is accused of 22 criminal counts including wire fraud, commodities fraud and attempted price manipulation. He has denied any wrongdoing.

U.S. authorities say Sarao used modified computer software to "spoof" the Chicago Mercantile Exchange (CME) market by placing buy or sell orders that were modified millions of times and then cancelled before they could be executed.

Having manipulated the market, he then placed genuine orders, making a large profit in the process.

They argue his actions contributed to the market instability which spread from the CME and led to the flash crash on May 6, 2010 when the Dow Jones Industrial Average briefly plunged more than 1,000 points, temporarily wiping out nearly $1 trillion in market value.

Giving evidence to London's Westminster Magistrates' court on Thursday, Professor Lawrence Harris of the Marshall School of Business at the University of Southern California said the orders placed by Sarao were genuine and had exposed him to the risk other traders would take them up.

"These orders were real representations of opportunities to trade," he told the court by videolink. "These are real orders, they're not bogus."

Harris, a former U.S. Securities and Exchange Commission chief economist, said traders placed and cancelled millions of orders every day, far more than were actually executed.

In a report submitted to the court, Harris said the suggestion of any causal relation between Sarao's trading and the flash crash was "highly speculative", saying it was the actions of an inexperienced trader at a large mutual fund that caused the market to fall rapidly.

But Mark Summers, the lawyer for the United States, said Sarao, who was arrested by British police on a U.S. warrant last April, had been a factor.

"The government alleges that the defendant on this day was heavily engaged in his spoofing activities," Summers said.

"He was, through that activity, contributing to that market imbalance. Along with other factors that were happening on that day, that market imbalance contributed to the flash crash."

If Sarao is extradited and convicted, the maximum U.S. sentences for the charges of which he is accused amount to more than 350 years in prison.

His lawyers argue that he was not breaking British laws and that if he was, he should then be tried in Britain.

"GETTING HIT ON THE SPOOFS"

Summers said the Briton, running a one-man operation, Nav Sarao Futures Ltd from his parents' home near Heathrow Airport in west London, had used specially adapted software to keep his trades from being executed by modifying or cancelling them.

"If I'm short I want to spoof it down," Sarao wrote in an email to the computer programmer.

Summers told the court that on May 4, 2010, Sarao had placed orders which were modified 7.4 million times, accounting for 42 percent of all modifications on the CME that day.

But the system was not foolproof and he had complained that some of his orders were being executed. In another email to the programmer, he said he was "getting hit on his spoofs and it was costing him too much money," Summers said.

Three contracts he placed on the day of the flash crash were thus executed, however he still made $878,000. His biggest single day's profit from alleged spoofing was $4 million on Aug. 4, 2011 and he made $40 million overall, Summer said.

If the judge approves extradition, the decision must be ratified by Britain's interior minister Theresa May, and his lawyer said it was very likely Sarao would appeal.

(Editing by Catherine Evans)